Wall Street sees stocks in 'correction' mode

Investors bet too early that rate increases would end, analysts say

SAN FRANCISCO (MarketWatch) -- They've been talking, and now the market seems to listening.

For a number of strategists, Wednesday's stock slide and the market's recent downturn pushed to the forefront a number of red flags indicating that the extended bull run is over, or for some, at least in need of a breather.

Just earlier this month, the Dow Jones Industrial Average
DJIA, +0.08%
was nearing its all-time closing high of 11,722.98 and as late as May 10, the possibility of a move higher appeared possible when the index closed at 11,642.65.

But the consumer-price index report released Wednesday seemed to unleash pent-up anxiety within the market about the country's inflation picture, due in part to red-hot commodity prices and on diminished hopes that the Federal Reserve might pause in its cycle of interest-rate increases. See archived story.

"I think going into last Thursday, the market very wrongly, in my opinion, had assumed that the Fed was ready to pause and actually read their statement as such," said Liz Ann Sonders, chief market strategist at Charles Schwab & Co., who said that she felt a "little odd" last week to be one of the seeming few who stated that the Fed wouldn't pause its rate hikes in June.

The Dow on Wednesday saw its biggest one-day point drop in more than three years and the S&P 500 Index
SPX, +0.04%
closed at its lowest level since Feb. 13 of this year. For the week, the blue-chip index lost 2.1%, the Nasdaq Composite Index
$COMPQ
logged a 2.2% loss and the S&P lost 1.9%. See Market Snapshot.

"We are in a correction within a bull market," said Mark Arbeter, chief technical strategist at Standard & Poor's, who said he's been monitoring a number of indications that have shown for some time the market was moving into a slowdown.

"You see all these deteriorations and divergences and you start warning people, and many times you're very early," he added, "and you scratch your head and say, 'When is this thing going to drop?'"

In any event, RBC Dain Rauscher analyst Bob Dickey advised investors to move quickly: "Waiting too long could also be the same as making the decision to do nothing and just taking what the market gives you."

Send in the bears?

The consumer-price report -- which showed that higher gasoline prices and a surge in housing costs pushed prices up 0.6% in April -- was "all the market had to hear" to move to the downside, according to Barry Hyman, equity market strategist at Ehrenkrantz King Nussbaum. See Economic Report.

"A minor correction ... has to be expected. We haven't had one the entire year ... so we just see this as a natural process," he said.

Michael Sheldon, chief market strategist at Spencer Clarke LLC, said that the market has become much more uncertain over the past few trading sessions: "The reason for that is it now appears that the Fed has more work to do ahead of it than previously thought."

Some of the groups that have performed the best lately are likely to see an above-average amount of profit-taking, Sheldon predicted, and topping his list would be emerging markets, small-cap stocks and commodity stocks.

In a note to clients, Standard & Poor's Arbeter pointed out that the S&P 500 "has sliced through quite a number of key short-term and intermediate-term technical supports like a hot knife through butter," including falls "right through its 50-day, 65-day and 80-day exponential moving averages, [as well as] its 150-day [and] 200-day exponential averages for the first time since Oct. 5."

Arbeter also expects an intermediate-term bottom in the next week or two and the S&P 500 to fall to 1,246, followed by snapback rally that could last throughout the summer.

"There's a lot of chart support right at 1,246, and that level also represents a 50% retracement of the October to May advance," the strategist said in an interview.

But the outlook for stocks after the summer looks bleaker to him as well as to Paul Desmond, president of Lowry Research in North Palm Beach, Fla.

"We think we are the verge of a bear market," said Desmond. He added that every four years since 1949 the market has hit a major bottom to mark the end of a bull run, the last major market bottom being in 2002.

"For the past four or five months, we've been seeing the signs of a major market top that would suggest the four-year cycle is going to repeat again," he added. "If you follow that forward and say, 'When would the next bottom be?' the answer is 2006, perhaps even early 2007."

Arbeter, like Desmond, also cited the four-year cycle as a primary reason that he sees the market hitting a colder spell. Both said that if the bear market does emerge, it's likely to come in October.

Parsing the numbers

One illustration offered by Desmond of technical weakness in the market is the deterioration in the amount of buying enthusiasm on the part of investors and a significant increase in the number of people who are trying to liquidate stocks.

Desmond said Lowry Research measures investor appetite for stocks through its Buying-Power Index and the desire to sell equities through its Selling-Power Index.

The Buying-Power index hit its high of 581 in August 2005, and since then it's been churning downward, he reported.

"When the Dow Jones Industrial Average was making new highs in early May, that measurement of investor demand had already dropped by 189 points and was at a multiyear low," said Desmond. "At the same time, the selling-pressure index is at a multiyear high. So it's saying that throughout this bull market, going back to the bottom of October 2002, the desire to sell has never been higher right at the time the market averages were making new highs."

Desmond also noted that Wednesday's decline raised another flag that a bear market is moving in, because it qualifies as a "90% downside day" in that 90% of all the volume traded was in stocks that declined for the day. Of all of the price changes, almost 95% of them occurred in the stocks that lost ground.

"When [90% downside days] occur at the end of an old bull market, that typically [shows] investor psychologically is changing over this period in which the internal indicators have been deteriorating."

Another worrisome trend for Desmond is that while the major indexes were moving higher, the number of stocks making new 52-week highs "has been drying up."

Arbeter agreed, and said figures from the New York Stock Exchange indicated that since late 2003, each successive high hit by the S&P 500 has been accompanied by fewer new 52-week highs.

In late 2003, about 18% of NYSE issues made new 52-week highs, he noted, and in July 2005, the percentage moved down to 14%; on the latest peak May 5, only about 11.5% of NYSE stocks had made new highs.

"The market is getting more selective as the bull ages," said Arbeter.

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